Accounting for trust

The problem with goodwill is that even in formal company accounts it is difficult to quantify – and indeed subject to significant variation across different accounting regimes. More importantly, though, in reality a large part of the difference between the ‘efficient’ (based on future cash flows) value of a company and its market capitalisation, as determined by the freely floating stockmarket, could be considered as positive or negative goodwill. It is this concept and its implication in understanding company performance that I want to focus on.

I have been thinking about goodwill, in particular, as a result of the recent news that complaints to the Financial Ombudsman Service have reached around 7000 per day. What does this tell us? Well, on the one hand, a statistician would note that the majority of these complaints are on the mis-selling of PPI and so the increase could be seen as a temporary ‘blip’ or at least exaggerated by the PPI situation. But the fact is, complaints have increased and however quickly the PPI scandal subsides, the reputational damage to financial services does not. This is inclined to make individuals more likely to complain – after all, you generally only complain once you have lost trust in a company or individual – and therefore will have an ongoing impact on the attitudes of individuals to financial services companies. In this way, the value of goodwill ascribable to these companies is diminished.

What is, however, more concerning is that it is not only those companies directly involved in any perceived wrongdoing that lose reputational and hence goodwill value. There is a clear negative halo effect in operation – companies with a perceived connection or in a similar area are also adversely impacted. In reality, with the case of PPI mis-selling, all financial services companies – even those with no connection whatsoever to PPI or banking – have been negatively affected. Similarly, as we all know, the global financial crisis has tarred most financial services firms, irrespective of their activities or behaviour. This negative writedown on goodwill has been felt by all, when it should only have been felt by some. While this may seem unfair, to a certain extent, financial services firms with their general reluctance to engage openly with customers, only have themselves to blame.

So is there any positive news? My suspicion is that the negative impact on valuations for financial services companies enables a stockpicker to differentiate between those unfairly marked down in value and those that really have damaged their reputations permanently. The recovery of trust in financial services is a long game and one that, for some companies, may be all but impossible. However, for those companies at the top of the trust pile – however much they may have been damaged in the short term by ongoing financial scandals and problems – in the medium term, their restoration to a fairer level of value is likely.

A good reputation, once lost, can be very difficult to regain. Companies with a tarnished reputation will face an uphill struggle to achieve customers’ trust. Notwithstanding this, those financial services firms that actively work to rebuild their reputations should find, in time, that they are distinguished from the wider industry not just by their customers, but by investors. Having a strong brand helps to prevent the commoditisation of a company’s products or services. Customers will buy from a brand they trust, something that is particularly true in financial services. Trusted brands therefore tend to have a loyal and growing client base. A solid customer base plus a strong competitive position are highly desirable attributes and something on which potential investors will place a premium value. Maintaining a company’s reputation can pay double dividends. The company itself will gain more customers and so will grow revenues and profits. Additionally, the company will be an attractive investment and therefore will expand its shareholder base and generate further cashflows. There may be no accounting for taste, but there certainly is accounting for trust and perhaps this is the biggest potential value in many companies – financial services firms included.

James Bateman is head of multi-manager and multi-asset portfolio management for Fidelity Worldwide Investment